January 29, 2016
We frequently get questions on buying preferred stocks at “wholesale” prices before they are listed on the NYSE or NASDAQ. Here’s a primer about the process.
When preferred shares are registered, the terms and conditions of the offering are negotiated with the underwriters. One of those negotiations to bring to your attention is how much the underwriter will be compensated for distributing the shares.
For instance, Public Storage offered preferred and negotiated an underwriting discount of 78.75 cents/share. Essentially, this means the underwriter “pays” $24.2125/share with the intention of re-selling the shares for $25/share. In a perfect world, the shares would sell for $25 — but this isn’t how it really works.
After the registration is accepted by the Securities and Exchange Commission (SEC) and becomes effective, there is a delay prior to the listing of shares on the NYSE (or NASDAQ). You will see in almost every prospectus or registration statement a clause that says "we intend to apply to have these shares listed on the NYSE under the symbol xxxxx. If this application is approved, trading of the shares is expected to begin within 30 days" (or something similar). It almost always takes at least three days (to as much as 10 days) to be approved for listing. Since time is money the underwriters are anxious to begin selling and they will apply to sell shares immediately on the OTC market–to the retail investor this is the ‘wholesale market’.
From this point on the shares are sold and it is pretty much a supply and demand situation — did the underwriters price the shares correctly? How anxious is the retail investor to buy the issue? The underwriters can gauge the appetite of the market for the shares at this point in time and sell the shares at whatever level they believe is correct.
What is the correct price to pay when buying in the OTC grey market? There is no answer to this question. The way we handle this is we do not jump in immediately. Instead, let hundreds of thousands of shares trade and note the pricing.
If we want the issue, we would likely buy on the second day and probably put an order in near the last price paid (although if there is a wide spread — say 20 cents, we would put in an order mid-range and wait — adjust up or down as necessary). Typically, if we want an issue on the OTC market, we have a belief that the shares will move a fair amount higher once they begin trading on the NYSE or NASDAQ. Thus, we are not going to quibble over a nickel — trying to save a nickel is a waste of time — a nickel is like 1 week or 10 days of dividends.
Remember, the OTC grey market is not a super-automated system like the big exchanges. As a result, information on pricing and volumes is limited — the use of common sense is paramount.
NEVER put in a “market” order for these shares. In fact, the systems I am familiar with do not allow a market order on the OTC market. You MUST use “limit” orders.
There is NO GUARANTEE that shares will move higher when trading moves to the NYSE or NASDAQ — many times they do, but not always.